Investments and Fair Value

Transcription

1 Investments and Fair Value Maryland State Society May 8, 2012 Diane Wasser Investments and Fair Value The Fair Value Measurement Topic, ASC 820, continues to challenge financial statement preparers, service providers and auditors. During this session we will address the nature of certain common plan investments as well as common reporting issues, including transfers between levels, proper disclosure of asset classes, and disclosures related to investments that are reported at fair valued based on net asset value. 2 1

2 Fair Value Measurements and Disclosures Plan management is responsible for valuation of investments and presenting the financial statements in accordance with GAAP Requires sufficient understanding of the nature of the plan s investments May use outside service provider or pricing service Auditor should obtain an understanding of entity s process for determining Fair value of investments Fair value disclosures, including fair value hierarchy levels Limited scope audit Certification does not change management s responsibilities 3 Plan Financial Statements Adoption Timeline - Fair Value Measurements FAS 35 Plan investments valued at fair value FAS 157 (adopt 2008) Apply new FV definition Hierarchy disclosures FSP FAS (adopt 2009) Disaggregate hierarchy disclosures by nature and risk category for equity and debt securities ASU NAV (adopt 2009) Use of NAV as a practical expedient for valuation Additional disclosures and hierarchy ASU (adopt 2010) Disaggregate hierarchy disclosures by nature and risk class for all FV assets and liabilities Disclose transfers between L1 and L2 Other new disclosures ASU (adopt 2011) Expanded disclosure of L3 activity ASU (adopt 2012) Description of valuation processes for L3 Unobservable inputs table (quantitative) for L3 Public entities to disclose all L1 and L2 transfers Public entities to provide narrative description of sensitivity of FV to changes in unobservable inputs (qualitative) 4 EBPAQC 2

3 Summary of Fair Valuation Guidance ASC 820 Guidance Summary of Changes FAS 157, Fair Value Measurements and Disclosure ASU , Investments in Certain Entities That Calculate Net Asset Value per Share (or its Equivalent) New FV definition Initial requirement for hierarchy table Initial requirement for level 3 roll forward Disclosure of g/l attributed to change in unrealized g/l of level 3 investments held at year end Transfers in & out of Level 3 NAV as practical expedient NAV hierarchy guidance, require major category NAV disclosures: Investment strategy, redemption requirements, unfunded commitments FSP Fair value when volume and level of activity have significantly decreased Disaggregate FV hierarchy table by nature and risk category for equity and debt securities ASU , Improving Disclosures about Fair Value Measurements ASU , Reporting Loans to Participants by Defined Contribution Pension Plans ASU , Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS Disaggregate FV hierarchy table by nature and risk class for all FV assets and liabilities Description of Level 2 and 3 investment valuation techniques and inputs Amount and reason for significant Level 1, 2, (& 3) transfers Policy for determining transfers Level 3 reconciliation gross presentation of purchases, sales, issuances, settlements (effective 2011) Participant loans are no longer a fair value measurement and therefore no longer required on FV hierarchy table Tweaks to FV measurement Narrative description of the sensitivity of FV to changes in unobservable inputs (qualitative) Description of valuation processes for Level 3 investments, how policies are decided, changes Unobservable inputs table (quantitative) for Level 3 investments Disclose all Level 1 & 2 transfers Nonpublic entities are exempt from qualitative discussion of Level 3 sensitivity and Level 1 & 2 transfers 5 ASU Fair Value New Disclosures for Level 3 Measurements For calendar year plans, effective January 1, 2011 Entities must separately disclose the following in the Level 3 activity rollforward Purchases Sales Issuances Settlements Formerly these could be netted In period of adoption, comparative disclosures not required 6 3

4 Fair Value Measurement Disclosures Divergence in practice, and incomplete or missing disclosures Examples Failure to breakout investments by class Changes to leveling as a result of errors vs. changes in observability, etc. When NAV used as a practical expedient, missing required additional disclosures (strategies, restrictions, unfunded commitments) 7 EXAMPLE DISCLOSURE: by class Level 1 Level 2 Level 3 Common stock: Energy Healthcare Consumer goods Open ended mutual funds: US Large Cap Equity International Stock Fixed Income Balanced Asset Backed Securities Residential Mortgage Backed Securities Commercial Mortgage Backed Securities Other Asset Backed Securities 8 4

5 Leveling Changes Certain changes result from true transfers due to a decrease or increase in observability Certain changes result from new guidance Certain changes result from errors in prior year leveling Reclassification footnote Consider restatement if material 9 ASU Additional guidance on fair value measurements of investments in certain entities that calculate net asset value per share Classification as level 2 or 3 requires judgment based on ability to redeem at NAV at the measurement date If have ability to redeem at NAV at measurement date level 2 If never can redeem at NAV level 3 If cannot redeem at NAV at the measurement date, but the investment may be redeemable at a future date, consider length of time until redeemable (if it is not known when able to redeem or cannot redeem in the near term at NAV level 3) 10 5

6 ASU Requires additional disclosures for level 2 and 3 whether or not NAV is used as fair value measurement Strategies, restrictions and unfunded commitments Watch if the entity has a different year end/different measurement date than the plan s year end Look at past history of estimations of NAV vs. final NAV Test underlying values at interim date Watch redemption restrictions 11 Example disclosure for investments reported at NAV ASU The following table for December 31, 2011 sets forth a summary of the Plan s investments with a reported NAV. Fair value Unfunded commitment Redemption Frequency Other redemption restrictions Redemption notice period Common Trust Funds (1) $xxx STIF fund (2) $xxx immediate none Equity index pooled separate accounts (3) $xxx quarterly 60 days Venture Capital Funds (4) $xxx $xxx,xxx Semi annually No redemptions in initial 3 year holding period 120 days 1. Common Trust Funds- Common trust funds are comprised of shares or units in commingled funds that are not publicly traded. Underlying assets in these funds primarily include publicly traded equity securities and fixed income securities and are valued at their Net Asset Values ( NAVs ) calculated by the fund sponsor and have daily or monthly liquidity. 2. Short-term investment fund strategies seek to invest in in high-quality, short-term securities. 3. Equity index fund strategies seek to replicate the movements of an index of a specific financial market, such as the Standards & Poor s (S&P) 500 Index, regardless of market conditions. 4. Venture capital funds invest in companies at their start-up phase primarily focused on the technology, telecommunications, 12 industrial and life sciences sectors. 6

7 Fair Value Measurements and Disclosures Whose job is it? Custodians provide the data Clients review the data and conclude Auditors validate and opine SAS No. 73 (AU 336), Using the Work of a Specialist Provides guidance that applies when an auditor uses the work of an actuary in the audit of a defined benefit plan or a health and welfare benefit plan. The SAS also applies if specialists are used to value investments in an employee benefit plan's financial statements. 13 ASU Fair Value Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs Effective for annual periods beginning after December 15, 2011 Prospective application Objective to converge U.S. GAAP and IFRS in this area Expanded Level 3 investment disclosures! Next Year 14 7

8 ASU Nonpublic entities are exempt from certain disclosure requirements: A qualitative discussion of the sensitivity of the FV to changes in unobservable inputs and the interrelationships between those inputs. Transfers between Levels 1 and 2 of the FV hierarchy Info required for public companies when FV is disclosed but not recognized in the financial statements 15 ASU Nonpublic entity, as defined by the codification, is any entity that does not meet any of the following conditions: a. Its debt or equity securities trade in a public market either on a stock exchange b. It is a conduit bond obligor for conduit debt securities that are traded in a public market c. It files with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market. d. It is required to file or furnish financial statements with the Securities and Exchange Commission. e. It is controlled by an entity covered by criteria (a) through (d) 16 8

9 FASB Exposure Draft: Technical Corrections (issued Oct 14, 2011): ASC 960, 962, 965 Net Change in Appreciation/Depreciation Para 280 and 290 of exposure draft proposes to disclose net appreciation (depreciation) by investment class for each Level 1, 2 and 3. Why this is a challenge: Levels stored at the asset level, not at the transaction (purchase or sale) level No transitional guidance Changes would be made as soon as issued with no provision for adoption Comment period ended Dec 13, See AICPA/FinREC letter 17 Deficiencies-Fair Value-PCAOB Inspection Findings PCAOB released several public documents citing fair value auditing deficiencies noted in their inspections: Firms used external pricing services or external valuation specialists to corroborate the values used by management but failed to: understand the methods or assumptions used by these external parties evaluate valuation methods or adequately test controls over issuers' valuation processes obtain a sufficient understanding of the valuation methods used by the parties providing these external valuations test the operating effectiveness of internal controls over various aspects of issuers' valuation processes to support the degree of reliance placed by the firms on those controls 18 9

10 PCAOB inspection findings Fair Value PCAOB released several public documents citing fair value auditing deficiencies noted in their inspections: Dec 6, 2011 PCAOB Staff Audit Alert No.9 Sept 29, 2010 Rule 4010 Report On Observations Audit Risk Areas Affected by the Economic Crisis c_crisis.pdf PCAOB Staff Audit Alerts Nos. 2, 3, Deficiencies-Investments-DOL Reviews & AICPA Peer Review Failure to test year end market values Failure to obtain proper certification for a limited scope audit Inadequate or missing disclosures related to investments Failure to adequately understand the type of investments the plan holds 20 10

11 Deficiencies-Investments- AICPA Professional Ethics Division & Peer Review Disclosures related to fully benefit-responsive investment contracts Investments that represent 5 percent or more of the Plan s net assets Adjustment to contract value The net change in fair value of each significant type of investment Fair market value (ASC 820) disclosures The certified information incorrectly included non-investment information, or improperly excluded information that was certified 21 Audit Objectives and Investments Limited vs. Full scope procedures Full (existence and valuation) Investment confirmation Purchases and sales testing throughout the year Year end market value testing Investment income testing - Interest & dividends Portals active response from third party Limited Certification Alternative Investments investments without a readily determinable market value Limited scope and full scope: Determine that the Plan s financial statements and disclosures are in compliance with GAAP 22 11

12 Audit Objectives and Investments The objectives of auditing procedures applied to investments and related transactions are to provide the auditor with a reasonable basis for concluding: Whether all investments are recorded and exist Whether investments are owned by the plan and are free of liens, pledges and other security interests or, if not, whether the security interests are identified. Whether investment principal and income transactions are recorded and investments are properly valued in conformity with generally accepted accounting principles Whether information about investments is properly presented and disclosed Whether investment transactions are initiated in accordance with the established investment policies 23 Audit Objectives and Investments Full Scope (existence and valuation) Obtain all information requested with the confirmation Trade date or settlement date Liens or encumbrances, or lack thereof Certification Confirmation Portal access document active response from a third party Separate Alternative Investment Confirmation 24 12

13 Audit Objectives and Investments Confirmation Portal access document active response from a third party In a highly automated environment auditors may face challenges in the confirmation process and therefore must carefully manage the confirmation process and refrain from accessing information available to clients. It is important to note that an auditor s online inquiry of a third party s database does not meet the auditor s confirmation responsibility under AU section 330. Instead, such online inquiry constitutes an alternative procedure. Refer to the full text of AU section 330 and 9330 for guidance when using electronic confirmations. 25 Audit Objectives and Investments Confirmation In addition to challenges with confirmation inquiries, when confirming investment existence and ownership with third party custodians or trustees in a full scope audit, auditors are often faced with challenges regarding the method of response. The challenges relate to electronic responses and those that generally do not address all requests contained in an auditors inquiry. AU Section 330, The Confirmation Process, requires an active response from a third party. Guidance, related to this, is available in AU Section 9330, The Confirmation Process Auditing Interpretations of Section 330. AU Section 9330 states that electronic responses are not precluded and highlights considerations to assist auditors with their determination of the reliability of the information obtained through the confirmation process, including consideration of the risk that the information obtained may not be from an authentic source; a respondent may not be knowledgeable about the information to be confirmed; or the integrity of the information may have been compromised

14 Audit Objectives and Investments Limited Scope Scope of the Audit (Limited vs. Full Scope) Determined ONLY by where investments are held Limited Scope Audit is permitted for plans with assets held by a qualified trustee/custodian: Bank Trust Company Similar institution Regulated savings and loan association Credit union Insurance company (do not refer to as custodian or trustee) Supervised and regulated and is subject to periodic examination by state or federal agency Election is available only if the Custodian certifies both the accuracy AND completeness of the investment information at year end AND during the year 27 Audit Objectives and Investments Auditors Responsibility Limited Scope Audits Obtain and read a copy of the certification Determine whether the entity issuing the certification is a qualifying institution under DOL regulations Compare the investment information certified to the financial information contained in the plan s financial statements and related disclosures Perform the necessary procedures to become satisfied that any received or disbursed amounts reported by the custodian were determined in accordance with the plan provisions Determine whether the form and content of the financial statement disclosures related to the investment information prepared and certified by the plan s custodian are in conformity with GAAP and are in compliance with the DOL s regulations 28 14

15 Audit Objectives and Investments Certification should be worded similar to: We hereby certify to the best of our knowledge the information contained in this report pursuant to 29 CFR is complete and accurate Does not apply to investments held by: Broker/dealers Investment company (mutual fund companies) UNLESS they have set up a separate Trust Company or eligible institution that has custody of the assets. Unusual wording is a problem 29 Audit Objectives and Investments Is the ENTIRE period under audit certified? Are all the investments certified? Are notes receivable from participants certified? Was there a change in trustee/custodian? If Yes: Assure opinion refers to all certifying institutions for the proper time periods Certifications NEVER cover participant level information 30 15

16 Audit Objectives and Investments Every certification is NOT reliable Unqualified institutions try to certify Qualified institutions sometimes provide unreliable certifications Be aware of hard-to-value assets Is certification appropriate (custodians only need to certify what is best available in their ordinary books and records) Is certification at year end Has value changed since prior year Is the custodian merely a conduit and not able to certify Watch for agency relationships Not an automatic no-no but additional information needed to verify the agency relationship 31 Audit Objectives and Investments DOL Regulations require: " such information as is contained within the ordinary business records of the bank, trust company, or similar institution and is needed by the plan administrator to comply with the requirements of section " Ordinary business records may be best-available values, which may or may not be fair value Which may or may not be as of year end 32 16

17 Audit Objectives and Investments Audit Procedures Limited Scope Full Scope Confirm assets directly with custodian X Agree the certified investment information to the Plan s financial statement X Year-end market value testing Investment Transaction Testing X X Test investment income allocation to participants X X Determine that the Plan s financial statement and disclosures are in compliance with GAAP X X 33 Valuation of Investments and ASC 820/FASB 157 While management may look to a valuation service provider for the mechanics of the valuation, management should have sufficient information to evaluate and independently challenge the valuation. Therefore, it is important that plan management is familiar with the plan assets in which a plan invests and the methods and significant assumptions used to value them, especially for investments in securities or other assets for which readily determinable fair market values do not exist. They can outsource mechanics but can NEVER outsource responsibility

18 Types of Investments Mutual Funds (Registered Investment Companies) Stable Value Funds (not mutual funds) Common Collective Trusts (have audited financial statements) Pooled Separate Accounts Money Market Mutual Funds Money Market Accounts Guaranteed Investment Contracts (GIC) Certificates of Deposit Limited Partnerships Hedge Funds Derivatives Funds of Funds Traditional Annuities 35 Unit of Account Investment Type Unit of Account Mutual fund Mutual fund share CCT (Common Collective Trust) CCT unit PSA (Pooled Separate Account) PSA unit Managed fund (Separate Account) Underlying investments Master Trust Underlying Investments 36 18

19 Investments Mutual Funds Registered Investment Companies Plan holds units of participation in mutual funds Units are valued at quoted market prices representing the NAV of the units held by the plan Audited 37 Investments Common Collective Trusts Generally plans acquire investment units/units of participation Units represent an undivided interest in the underlying assets of the trust The purchase or redemption price of the units is determined periodically by the trustee based on the current market values of the underlying assets of the fund. Audited If audited financial statements do not need certain disclosures 38 19

20 Investments Investments commonly associated with Insurance Companies General Account Products Deposit Administration/Immediate Participation Guarantee Contracts Traditional Guaranteed Investment Contracts (GICs) Evergreen guaranteed rate products Synthetic GICs Separate Accounts Pooled Individual 39 Investments Insurance Company General Accounts Used to fund liabilities associated with various insurance products Contractual guarantees for general account contracts backed by full faith and credit of the issuer Specific securities within the general account are not carved out and attributed to any specific contract holder Ability to satisfy contractual guarantees is dependent on the issuer s claims paying ability 40 20

21 Investments Pooled Separate Accounts Read agreements Redemption restrictions Unit of account 41 Investments Separate Account Mutual Fund Unit Value Portfolio holdings No public price Part of investment contract Asset/liability of insurance company May be audited Share price/nav Portfolio holdings Public Price Held in separate custodial account May be omnibus or plan level Audited 42 21

22 Valuation of Investments Common valuation practices General Account GICs Income approach, present value of future cash flows Separate Accounts Net Asset Value/Unit value 43 Alternative Investments Hedge funds Public or not public audited financial statements Subscription agreements Management agreements Limited Partnerships Partnership agreements 44 22

23 ???????????? 45 IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein

24 Investments and Fair Value May 8, 2012 Diane Wasser 24